Bank of Canada still wary rising debt, high home prices could lead to housing market 'shock'

The Bank of Canada said its worst-case scenario, which is unlikely to occur, involves a major squeeze on homeowners’ ability to service their debt and 'cause serious and broad-based declines in house prices'

OTTAWA — The Bank of Canada is piling on more concerns over the country’s housing market, warning that rising household debt and regional price imbalances could lead to an “adverse shock” to the sector.

If those vulnerabilities remain — or even intensify — the central bank said Tuesday it could lead to a major squeeze on homeowners’ ability service their debt and “cause serious and broad-based declines in house prices.”

However, that worst-case scenario is buffered by the acknowledgement “its probability of occurring remains low,” the Bank of Canada said in its twice-yearly Financial System Review.

Canada’s struggling economy only recently climbed out of a first-half recession this year, driven by the collapse of oil prices that depressed resources-dependent provinces, such as Alberta and Saskatchewan. The outlook by analysts for overall growth in 2016 is for a meagre one per cent.

The Bank of Canada — led by governor Stephen Poloz — has already cut its trendsetting lending rate twice since the start of this year. So far, analysts see no change in that rate until late 2016 or beyond.

While that has helped encourage more into the housing market, it has also heightened concerns over record-high consumer debt.

At the same time, “the drop in commodity prices in 2015 has reduced Canadian incomes and wealth,” the central bank said. Even so, “to date there is no evidence of a significant increase in loan delinquency rates.”

“Housing activity should stabilize in line with economic growth, as the driver of growth in the economy switches from household spending to non-resources exports,” Poloz said in a statement, accompanying Tuesday’s FSR release.

“Certain vulnerabilities are still edging higher, but recent changes by Canadian authorities to the rule for mortgage financing will help to mitigate these risks as we move into 2016.”

That said, views that volatility in global markets has “spiked temporarily” over concerns that China — now the world’s second-largest economy — is showing increasing signs of financial and economic stress as it moves toward a more open economy.

Other so-called emerging markets — especially those with commodity-dependent economies — are struggling to maintain growth.

Although the Bank of Canada views the risks to households as unchanged from its Financial System Review published in June, the Finance Department on Friday took is own steps to buffer the more vulnerable households.

Ottawa will tighten lending rules for residential mortgages, beginning in February, setting a minimum down payment of 10 per cent on the portion of home prices over $500,000.

The changes were primarily targeted at the hottest housing markets, Vancouver and Toronto. Other parts of Canada have been relatively stable.

During a news conference Tuesday, Poloz said central bank officials “were fully consulted” on the federal changes to mortgage requirements.

“On the contents of the announcement, we were given a heads up. But it was not surprising in the sense that we has been talking about it,” the governor told reporters in Ottawa.

“Given the situation we face, it’s constructive change and . . . we have to watch its effects.”

Poloz added: “It’s not obvious how it will all turn out at this stage.”

Meanwhile, asked about Wednesday’s rate decision by the U.S. Federal Reserve — which is widely expected to mark the first hike since eight year, Poloz said that “divergence is something we should be expecting.”

“Usually you think of the Canadian economy following the U.S. economy fairly closely. This will be one of those places where it really doesn’t. It will follow, parts of it are following, but as a macro statement there’ll be a divergence there — we’re already seeing it,” he said.

“So, you should expect a divergence in policy too. For now, that’s about all we can says as we continue to watch it unfold and continue to incorporate the new data as they show up.”